Non interest bearing notes payable are issued by a business for cash, and are liabilities representing amounts owed by the business to a third party.
As the name implies, a non interest bearing note or zero interest note, does not have an interest rate and does not charge periodic interest payments on the outstanding liability. In order for the lender to get a return on their zero interest notes payable, the notes are issued at a lower price than their face value.
The difference between the face value of the notes payable and the cash received is referred to as the discount, and represents the cost to the business of issuing the note. The discount is amortized over the lifetime of the notes.
Non Interest Bearing Note Payable on the Balance Sheet
Short term interest bearing notes payable are due within one year from the balance sheet date and classified under current liabilities in the balance sheet, long term notes payable have terms exceeding one year and are classified as long term liabilities in the balance sheet.
Non Interest Bearing Note Example Journal Entry
Suppose for example, a business borrowed 7,273 cash from a lender by signing a 12 month, non interest bearing note payable with a face value of 8,000. The business receives cash of 7,273 in return for having to pay back the lender 8,000 in twelve months time.
The cash amount in fact represents the present value of the notes payable and the ‘interest’ included is referred to as the discount on notes payable.
The present value of the non interest bearing note payable is calculated using the present value formula, PV = FV / (1 + i%)n, where FV = future value, in this case 8,000, i% = the interest rate, say 10% and n= the term in years, in this case 1 year.
PV = FV / (1 + i%)n PV = 8,000 /(1 + 10%) = 7,273
The non interest bearing note payable would be recorded as follows:
|Discount on notes payable||727|
The discount on notes payable account is a balance sheet contra liability account, as it is netted off against the notes payable account to show the net liability.
Each month a portion of the discount on the notes payable is amortized as an interest expense. In the example above, the amount is 727 / 12 = 61 per month.
|Discount on notes payable||61|
At the end of the term, all the discount has been amortized as an expense to the income statement, the balance on the discount on notes payable account is zero, and the balance on the non interest bearing notes payable account is reduced to zero when payment of the face value is made to the lender.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.